The great price crash of 2014 could well turn out to be one of the defining events of the decade, for it has the potential to bring major changes to the oil markets, not only for the next five years, but even into the 2020s. Between June of 2014 and the end of the year, the price of Brent crude fell from circa $115 a barrel to around $57 by the end of the year. The cause of the crash was a combination of rapid growth in US shale oil production and weakened demand for oil products largely stemming from the slowing Chinese economy and continuing weakness in Europe, the US, Japan and other countries. The result was a global oil surplus of 1.5 – 2 million b/d.

The price slide was exacerbated by the reasonable refusal of any of the major oil producers, especially the Gulf Arab members of OPEC, to make significant cuts in crude production. The lack of the traditional OPEC production cuts in times of falling prices has led to accusations that the Gulf Arabs are deliberately keeping production up in order to drive high-cost US shale oil producers from the market or hurt the economies of geopolitical adversaries such as Iran or Russia. By contrast, the Saudis argue that as a low-cost producer, it isn’t necessary for them to cut production nor is it in their interest to do so.

So far there has been little decline in production attributable to the price drop, but numerous high-cost producers of shale oil, tar sands oil, and deep-water oil have announced plans for significant cuts in their drilling and other investments related to oil production during 2015. Some sectors of the oil industry such as those operating nearly depleted stripper wells, which produce some 700,000 b/d in the US, are likely to close down if prices stay low as they would be no longer economical. Those shale oil producers in North Dakota who are not connected to pipelines have seen the wellhead price of their crude fall to nearly $30 a barrel.

While some sections of the oil industry are almost certain to be hurt next year, some are wondering if a collapse of the ruble or wide scale default on the junk bonds that are financing much of the shale oil boom might trigger wider economic problems. For now conventional wisdom is saying that the end of the price drop is not in sight.

2. Continued Growth of US Shale Oil Production

During 2014, the multi-year growth trend in US oil production continued, even accelerated. From a 38-year low of 5 million b/d in 2008, production during 2014 is estimated to have averaged roughly 8.6 million, well above the 7.45 million b/d averaged during 2013. EIA’s latest data, for October 2014, showed production reached 9.05 million b/d, with year-over-year production up over 1.3 million. That means the increase in U.S. crude oil production over the last three years averaged roughly 1 million b/d each year. That is by far the fastest rate of increase, as well as the largest absolute increase, in US crude oil production history. It might also be the largest three-year oil production increase in world oil production history, excluding Saudi Arabia’s role as a periodic swing producer.

Production from shale oil is responsible for virtually all the net increase in US production. The two top shale-oil-producing states—Texas and North Dakota—now account for over 50% of US crude output, with production still growing strongly at the end of 2014. By comparison, production from the other 48 states combined has remained flat for over four years, totally roughly 4 million b/d. Annual gains were highest from the Eagle Ford shale oil play in Texas, the North Dakota’s Bakken formation, and five formations in the Permian basin (Spraberry, Bone Spring, Wolfcamp, Delaware and Glorieta/Yeso).

Factors which fostered the rapid growth of the shale oil plays included easy access to the most productive portions—the sweet spots—plus technology advances, cheap financing, ability to expand some key infrastructure such as pipelines (esp. in Texas), supportive state governments, high oil prices (until 3rd quarter 2014), and more.

Yet throughout 2014, the year of record growth in the US oil production, warning signs popped up that the record boom might soon enter its inevitable slowdown phase. Early in the year, several late-comers to the shale boom—oil super-major Shell among others—pulled out of their commitments to shale oil, citing a need to sell marginal and/or expensive projects. Despite efficiencies gained through technological improvements, the cost of drilling and completing wells and building take-away capacity remained high. That drove up oil company debt; a mid-year analysis of 61 shale drillers by Bloomberg News indicated that shale debt doubled over the last four years. Other items around the edges also changed, such as North Dakota’s regulations to limit flared gas associated with oil wells. On Wall Street, share prices of production companies lagged broader market indices.

Throughout the year, a few but growing number of reports by industry analysts questioned how long drilling could not only offset the rapid decline rates of new shale oil wells but continue to increase total production from shale plays. In particular, retired geologist David Hughes probed the nation’s shale oil well production data and concluded that, based on the limited number of drillable well sites remaining, especially in the productive sweet spots in major plays, the shale oil boom would plateau in the 2016-2017 time frame, then decline more rapidly than most others project. Pile on the oil price crash described above and most agree the boom will lose considerable steam, starting in the second half of 2015.

For the last several years, media headlines on the US side of the Atlantic have rightfully touted the ongoing and historic oil boom in North America. But during that same time frame, apart from covering the impact of the “Arab spring,” Syria, and ISIL on oil production in the Middle East and North Africa, the oil supply story from elsewhere around the world generally flies under the radar screen. Perhaps that’s because it has generally been flat, and 2014 was no exception to that trend.

World-wide production of C&C (crude oil and lease condensate—the most versatile, energy-dense and valuable of the petroleum liquids) increased from just under 74 million barrels a day in 2005 to roughly 78 mb/day in 2014.

Nearly all of that increase (3.6 million b/d) came from North America, and nearly all of that came from expensive unconventional oil—shale oil and tar sands. Outside of North America, world C&C production has remained relatively flat since 2005.

When it comes to non-OPEC contributions to world oil supply, stories not covering North America tend to focus on new discoveries and upside developments: offshore Brazil and West Africa, on-shore East Africa, the recovery of production in Colombia, a comeback in Oman, Russia’s post-Soviet increases, the potential created by new laws in Mexico, etc. But offsetting those gains are the sustained declines from formerly large producers (Mexico, Norway, the U.K., Indonesia, Egypt, Malaysia, etc.) and smaller producers (Australia, Denmark, Vietnam, and others) in the non-OPEC realm.

Two non-OPEC producers, which rank among the world’s top five (#1 Russia at 10.1 million b/d and #4 China at 4.2 million b/d) appear to have hit production plateaus during 2014. If that proves to be true, how long Russia and China remain within a narrow production band on their plateaus is a pair of storylines to follow going forward.

4. Iraq

On June 5th of 2014 the Islamic State of Iraq and the Levant (ISIL) began a major offensive against Iraqi government forces, overrunning numerous towns and cities in northern Iraq, at one point close getting close to Baghdad. A disappointingly large share of Iraq’s regular army melted away before the offensive leaving the defense of the country largely in the hands of the Kurd’s Peshmerga and reactivated Shiite militia. The unexpected success of the ISIL offensive combined with their brutality towards prisoners and peoples of different religions, however, soon changed the political, military and oil production landscape in Iraq.

When ISIL forces came close to capturing Iraq’s northern oilfields around Kirkuk, Kurdish forces occupied the fields and sent Iraqi managers home. The brutality of the ISIL towards its captives brought the US and some 60 countries into a coalition against ISIL. The Iranians joined in too. While the US and other foreign governments, with the exception of Iran, were not willing to risk casualties by directly participating in ground combat against ISIL, several of them including the US began air strikes against ISIL forces and facilities. Many others provided military training and aid mostly to the Kurdish forces.

The outside intervention blunted ISIL’s move towards Baghdad and the southern Iraqi oilfields; gave the Kurds enough air support so they could keep ISIL out of Kurdistan and away from the Kirkuk oilfields; and allowed the Kurds and the Iran-supported Shiite militias to begin offensives to retake ISIL-held territory. Airpower neutralized the utility to ISIL of the large numbers of vehicles and heavy weapons they had captured from fleeing Iraqi forces in June.

The year’s events brought about several major changes in Iraq’s oil situation. With the government in Baghdad severely weakened by the ISIL offensive and the Kurds robust defense of their homeland, isolated Kurdish villages, and the northern oilfields, Erbil was in a much stronger position in dealing with Baghdad over the distribution of oil revenues. In effect, after the ISIL offensive, the Kurd’s Peshmerga was the most effective and cohesive military force left in the country. This resulted in large quantities of supplies of military equipment and the accompanying training coming to the Kurdish forces.

The return of US airpower and some 3,000 military advisors/trainers ensures that the Iraqi oilfields are unlikely to be captured or closed down by ISIL forces in the immediate future. The Kurd’s newfound political leverage resulted in an agreement with Baghdad, which allows Kurdish oil and oil from the Kirkuk oilfields to be exported via Kurdistan to world markets. Iraq and Erbil now have an agreement on sharing the oil revenue and Baghdad is making large payments to Erbil to support the Kurdish military forces.

A side issue to the Iraqi situation is that Iran, which is severely stressed financially from the sanctions and low oil prices, is now deeply involved helping Shiite-controlled Baghdad fight ISIL – ironically on the same side as the US for a change. This in turn could have an impact on the Iranian nuclear negotiations, which likely will be coming to a head in 2015. At year’s end it seems that Iraqi oil will continue to be safely exported for the immediate future and there also seem to be good prospects that oil exports will increase next year from northern and southern Iraq plus new wells in Kurdistan.

5. Russia

The geopolitical status of Russia, the world’s largest oil producer, changed dramatically during 2014. After unrest in Ukraine during late 2013 and early 2014 that led to a leadership change and a lean away from Russia towards Western Europe, Russia surreptitiously invaded and took over the Crimea portion of the Ukraine. After a subsequent supportive vote of the people of Crimea, Russia effectively annexed Crimea. The reaction from much of the world, including several United Nations resolutions, was swift and highly critical.

Previous tiffs between Russia and Ukraine over payments and prices for gas shipped to Europe were dwarfed as responses to the Crimean takeover unfolded. Trade restrictions and other sanctions have been imposed on Russia, making it tougher for them to find funds to finance petroleum operations. They have already announced a postponement of a major drilling effort in the arctic and have rerouted their southstream gas pipeline project to Turkey and away from southern Europe.

During the fourth quarter of 2014, the combination of sanctions plus a near halving in the price of oil dealt a devastating blow to Russia’s economy. The ruble dropped roughly 50 percent from the start of the year through mid-December but partially recovered later in the month after the central bank intervened. Since oil and gas make up 70% of Russia’s exports, the dropping ruble and the falling price of oil is slashing Russian revenues from their petroleum trade, pushing them into recession and possibly much worse.

Whether through inspiration or desperation, throughout 2014 Russia steadily developed a closer relationship with China, centered on their energy sector. Back in May, Russia signed a $400 billion 30-year deal with China; through it, Russia’s Gazprom will ship natural gas to the China National Petroleum Corp. In December, Russia and China signed a currency swap deal to help facilitate bilateral banking and trade.

What will Russia’s shift towards China mean to world energy trade and supplies? While it’s too early to tell, odds are that even bigger changes could happen this year: more deals, more shift by Russia away from Europe towards China.

6. Iran Nuclear Situation

The success or failure of the ongoing negotiations with Iran over its capabilities to manufacture nuclear weapons could be extremely important to Middle Eastern oil exports in the near future.

Should the talks fail and the Iranians remain free to continue enriching uranium, not only will sanctions remain in place indefinitely, but the Israelis say they will bomb Iran’s nuclear facilities as they have done in Iraq and Syria. Tehran in turn says it will close the Straits of Hormuz thereby shutting down the 17 million b/d day of oil exports through the straits. This would likely lead to military action against Iran by the world’s oil importers, who would be devastated by the loss of oil from Iraq, Saudi Arabia, Iran, and the smaller Gulf states.

As Iran never tires of saying that it does not want nuclear weapons, but only seeks to build and fuel nuclear power stations, an agreement safeguarding this program should be relatively easy to reach. However, Iran is an old and proud nation, which says it wants no limits on its sovereign powers as demanded by Israel and the West. Moreover, it is in an endless confrontation with Israel which likely has accumulated enough unacknowledged nuclear weapons to destroy Iran in a matter of minutes. Without the possibility that Iran has at least the handful of nuclear weapons that it would take to destroy Israel there would be no mutual deterrence.

Like so many other things linked to oil prices, Iran is in serious economic difficulties at the minute and would clearly seek to have the Western sanctions lifted by reaching an agreement. Iran’s President Rouhani seems sincere in his efforts to reach an agreement, but he is stymied by the current Iranian theocratic political system, which leaves an Ayatollah as the supreme decision maker and dozens of special interests competing for his ear. In short, an agreement probably depends more on the ebb and flow of politics in Tehran than anything an outside government can offer.

The nuclear talks have already had two extensions, and insiders are hopeful that an agreement can be reached in the coming year. If the talks should fail, however, and the Israelis decide to take matters into their own hands, the situation could quickly deteriorate into a major threat to global peace and the global economy.

7. Political Instability Still Impacting Exports and Supply in 2014

In a perfect world, at least from the perspective of a few oil exporters, there could conceivably be two or more million additional barrels of oil on world markets today, much of it not needed domestically and thus ready for export. That’s a rough approximation of how much oil is off the market due to factors such as political instability and violence. What would it take to return those barrels to the market? A miraculous peace offensive…. followed by a lot of work and investment. It won’t all happen; in fact, the status quo is more likely. But, in theory: If the Sudans could get along, another 250,000 b/d might return to the market. Peace in Yemen could conceivably boost production by a similar 250,000 b/d, back to where it was.

What if the oil thefts and related strife in Nigeria melted away? We might see another 250,000 return to the market. Ditto with policy shifts in Venezuela: another 250,000 b/d or so.

Syria’s civil war cut production by roughly 400,000 b/d. It could be that none of that former production capacity will see the light of day for another decade or more, but it once was there.

If Libya’s civil strife melted away, another 600,000 to 800,000 b/d could be for sale, most of it as exports.

What if Iran and the U.S. finally saw eye to eye on Iran’s nuclear–related projects, opening up the country’s petroleum sector to foreign money and expertise? Perhaps their production could increase, over the course of several years, by 750,000 b/d or more from their estimated current production of 3.25 million b/d today towards the 4 million they produced before sanctions were imposed.

Finally, while Iraq’s production of well over 3 million b/d today is the highest since 1979, how much higher might it be if sectarian strife and the conflict with ISIL melted away? Another 1 or 2 million barrels, maybe more?

The bottom line: substantial amounts of former and potential oil production remained sidelined by violence and political disputes during 2014. Based on trends and realities on the ground at year’s end, the likelihood that any of this sidelined oil will return to the market anytime soon may be less likely than the possibility that more present production will be forcibly removed from world supplies.

8. Major Cutbacks in IOC Capital Spending

The major capital expenditure reductions during 2014 started off in late January with Royal Dutch Shell’s CEO citing the need for “rigorous capital discipline” as they shelved their 2014 plans to drill in the Chukchi Sea off Alaska’s coast. The year ended with Chevron’s announcement in mid-December that they were “indefinitely postponing” a similar effort for the Arctic—their plan to drill a well out in the Beaufort Sea off the coast of Canada’s Northwest Territories. Chevron blamed economic uncertainty caused by the large six-month drop in world oil prices. But while Chevron’s plans mean they eventually lose a mere $100 million spent to lease the drilling location, Shell must stew about the reported $5 billion they’ve spent on their delayed arctic project thus far for leases, equipment, etc.

These two incidents bookend a long string of cutbacks in capital expenditures announced by companies large and small. A surprising number of capital spending cuts were announced, especially by larger companies, during the first half of the year. For example, back in March Shell took a $1.65 billion loss on their Voyageur upgraded project rather than continue with the investment of an addition $5 billion to complete the project. Shell also offloaded several billion dollars’ worth of non-prime shale oil acreage, stating that “the financial performance there is frankly not acceptable.

For most corporations, the major driver behind the late-year cuts was the multi-year string of rising development costs vs. flat and then declining revenue, forcing the companies to either take on additional debt or sell assets. Nearly everyone went the debt route; EIA reported mid-year that in their worldwide study of 127 IOCs, they discovered that as a group the companies’ net debt had ballooned by $106 billion between March 2013 and March 2014. Later in the year, industry analyst Wood Mackenzie reported that if oil prices stayed near $60, the 40 largest IOCs would need to cut spending by 37%, or $170 billion.

Not surprisingly, announcements about the largest cuts came during November and December, following the oil price crash. Cuts in capital budgets typically ranged from 20%–the cut which Conoco Phillips announced—on up to a one-third reduction by Canada’s Husky Energy which is slashing its oil sands budget by 45%. Cuts by deep-water drillers are sufficiently numerous that day rates for drilling rigs dropped substantially as well.

Several corporations such as ExxonMobil, Chevron and Whiting Petroleum are delaying announcement of their 2015 capital spending budgets from December into January or February in hopes that oil prices will stop their declines long enough to give guidance. But whenever those announcements are made, they will likely point to the largest capital spending budget cuts in many years.

Robin Allan is chairman of the independent explorers’ association Brindex and a director with Premier Oil. In late December he described the impact of crashed oil prices on the North Sea as a crisis. “It’s close to collapse. In terms of new investments – there will be none. Everyone is retreating; people are being laid off at most companies this week and in the coming weeks. Budgets for 2015 are being cut by everyone.”

9. China’s Economic Slowdown

For the last 30 years the Chinese have accomplished one of the most spectacular economic growth records in recorded history. Since the reforms of 1979, China has been growing at circa 10 percent a year and is now thought to have the world’s largest economy. Much of this growth was fueled by a massive increase in coal production, but China’s oil consumption also has risen from 3 million b/d 20 years ago to circa 11 million b/d this year with over half of it being imported. In 2015 China may become the world’s largest oil importer as US imports slow due to large increases in domestic production.

The Chinese, however, are now facing significant economic problems. The rapid growth over the last 30 years has taken place with minimal concern for the environment so the country is faced with extremely serious air, water, and soil pollution problems. In the last few years, the spectacular rates of growth and increases in oil consumption have eased, so that the rate of economic growth is now about 7% and some economists believe it may be considerably lower. Consumption of oil is no longer growing as fast as in the past, although efforts to build a strategic reserve at bargain prices is keeping imports strong this year.

For many years, China has been the factory of the world, exporting prodigious quantities of goods and importing massive amounts of raw materials. Now production increases from this gigantic factory are slowing, reducing imports from many nations around the world, which in turn are using less oil to supply China with raw materials.

Beijing has set ambitious goals to cut air and water pollution; the former has become so bad that in some heavily populated cites air pollution is becoming a matter of life or death for many. This transition to cleaner energy will not come cheaply and will slow growth in fossil fuel consumption in coming years. It seems fair to say that a major reason for a slowing of global oil demand this year can be traced to the slowing of the Chinese economy.

10. US Energy Dialogue and Control of Congress

The rapid growth in US oil and natural gas production in recent years has led to much, likely misplaced, optimism about the future of the industry, at least over the long term. Many oil producers would like to sell their oil and gas at world prices, which are higher than those prevailing in the US. Others would like to see the Keystone XL pipeline from Canada built in order to expand what is seen as a nearly inexhaustible supply of tar sands oil from Canada. Opposed to the efforts to lift the long-standing oil export embargo are those who believe that rapidly increasing oil and gas production from shale deposits is likely to be short-lived and that it is better to keep US oil and resources in the ground for future generations rather than exporting it for short-term profits.

Thus an ideological dispute over energy policy has arisen in the US between those who do not believe climate change is a serious threat and believe future development of boundless US oil and gas resources is being hampered by pointless regulation; and those who believe there are serious problems just ahead. This dispute has entered the political realm with the newly elected Congress determined to eliminate what they consider to be ill-conceived federal regulation that is only holding up US economic progress.

During the next two years the Congress will pass, and President Obama is likely to veto, legislation which directly threatens environmental regulations. Beyond this the course of oil prices will likely play a major role in legislation.

Finally, as part of the background discussion to the above policy debate during 2014, a number of leading analysts and commentators declared in a loud and definitive voice that “peak oil is dead.” We beg to differ. It appears that worldwide production of conventional crude oil peaked in 2005 and has remained relatively flat. Since 2005, it is primarily the surge in expensive unconventional shale oil production in North America that has sustained an expansion in worldwide crude oil supply. In the aftermath of last year’s June-December oil price crash of 50%—which may not yet have bottomed—the worldwide oil industry is wobbling in the footsteps of a wobbling world economy. Beyond 2015, the notion that substantial annual production increases will continue, thanks to massive drilling backed by heavily borrowed money, appears to us to be living on borrowed time.

Bottom Line

Our view is that world oil production is now on a bumpy plateau that could see a modest peak during 2015 or soon thereafter, followed by a struggle to remain on that plateau. That perspective is based on four assumptions, explored in more depth above:

Drilling continues, but at a slower pace due to the collision between relatively high costs and high debt vs. declining revenues;

Some level of violence in some oil producing countries continues to withhold potential increases from the market;

The world’s economy (outside of North America) will not recover quickly, thus demand for oil may remain soft; this will squeeze high-cost oil producers as well as oil-exporting countries which rely heavily on higher oil prices to balance their budgets.